New regulations could be lulling investors into a false sense of security when it comes to fund charges, with significant fees exempt from the “additional transaction costs” figure and asset managers attempting to bend the rules about what they need to show.
This is according to Richard Maitland, head of charities at Sarasin & Partners. Since 3 January, Mifid II – the Markets in Financial Instruments Directive II – has required asset managers to disclose additional transaction costs that are charged to their funds separately from the ongoing charges figure.
However, Maitland said that while MIFID II is a step in the right direction and has increased transparency, he warned it would be a mistake to fully trust the figures that are now given.
“I have had dealings with at least one of the big five accountancy firms who are in effect being asked by many investment managers ‘just how far and how close can we sail to the wind on this before we get embarrassed?’.
“So we know there are people out there who are going to play to the rules, to the letter of the law, but not necessarily the spirit.”
Maitland said there are two significant costs that someone operating within the letter of the law would not be obliged to include: taxes and some third-party fees. He described not having to declare taxes as “pretty critical” with VAT on investment management fees at 20 per cent.
“Depending on whether you are in a fund structure in which VAT is charged or not, that is a difference of probably 10 to 15 basis points.”
“And third-party fund costs,” he added. “They’re included, aren’t they? Well no, they are not – they are if you buy other people’s open-ended funds, so unit trusts and OEICs, but not if you hold investment trusts.
“So if I were a fund manager, I could have 20 per cent of a client’s portfolio invested in a Japanese unit trust, an American unit trust, a smaller companies unit trust, and then flip the entire thing just before the end of the year into the IT equivalents, because you know some fund managers run both ITs and unit trusts. And that one move means that seemingly under the new regime I reduced the client’s costs appreciably.”
“If you are investing 20 or 30 per cent of a fund in other funds, that’s probably another 15 basis points [bps]. So VAT and the third-party point on investment trusts, that is 25bps of costs that if I operate to the letter of the new law, I can probably not report. If you are paying an initial 1 per cent in charges, that might add an extra 25 per cent to your total costs.”
Maitland pointed to a chart in Sarasin’s biennial Investment Compendium showing how the actual cost of investment management can be close to twice the base case fee, depending on how charges are calculated.
Source: Sarasin & Partners Compendium of Investment
However, he admitted there is so much “devil in the detail”, you almost need a degree in investment to understand it all. He said the main point is that investors need to be aware that not every element of cost that can affect their return is going to be included and the difference between the charge you are quoted and what you actually pay can have a significant impact on your overall return.
“If you just read the headlines, you probably think you are about to be shown everything and you will probably relax because the regulator is going to do the job for you and ensure all the costs are transparent,” he continued.
“But I think moments when people relax are among the most dangerous because things go on in your portfolio that you are probably not aware of. This for me has been a really good bit of progress, but just for the moment, it’s still quite dangerous.”
James Hutton, co-author of the compendium and a business partner at Sarasin, said that one of the biggest barriers to transparency in the industry is jargon. He added that while this is a by-product of an industry “at the cutting edge” of creating new financial products, there are terms used by competitors that even he needs to look up.
Maitland added: “The FCA has been keen that we use terms like VAR [value at risk], but hands up who knows what VAR is?
“I think this is something that most people know about, but five years nobody did and there are a lot of people who are recipients of VAR data who really don’t know what it means. James is right, we create an awful lot of things but the onus is on us.
“The great skill in life is to explain complex things and complex theories using layman’s terms without talking down to your readership, your electorate or your clients.”
Hutton finished by saying that while the industry will always use some terminology that is not immediately clear to the man on the street – the use of Greek letters to describe a product’s relationship to its benchmark being an obvious example – he said it all comes back to the question of whether you are investing in a product doing things that you don’t understand.
“And if that’s the case, should you be investing in it?”